Confluence Of Private And Mutual Funds
University of St. Thomas, Minnesota – School of Law; European Corporate Governance Institute (ECGI)
January 13, 2016
Elgar Handbook on Mutual Funds, 2016, Forthcoming
The growth of the private fund industry and the proliferation of retail alternative funds in combination with the fundamental reshaping of the regulatory landscape for the private fund industry suggest that mutual funds are becoming more like hedge funds as a matter of investment strategy while hedge funds are becoming more like mutual funds as a matter of the regulatory framework. The paper shows that confluence of mutual and private funds has implications for the evolution of the private fund industry, the governance of the mutual fund industry, the growth of the retail alternative fund market, and the structure of federal securities regulation.
Confluence Of Private And Mutual Funds – Introduction
A combination of market forces and regulatory reform are calling into question the traditional distinctions between mutual and private funds. Mutual funds and private funds occupy distinct segments of the investment market, employ different investment strategies, and serve largely different classes of investors. They are subject to different legal rules. However, the emergence and proliferation of so-called retail alternative or hybrid funds, including hedged mutual funds and synthetic hedge funds; increasing side-by- side management of mutual funds and hedge funds; and public offerings of alternative asset managers, among other investor-driven factors, in combination with the fundamental reshaping of the regulatory landscape for the private fund industry through the Dodd-Frank Act and the Jumpstart Our Business Startups Act (“JOBS Act”) suggest that the traditional distinction between mutual and private funds may be eroding.
The term “confluence” as used in this article in the context of mutual and private funds, connotes two separate yet connected phenomena with related consequences. Mutual funds are becoming more like hedge funds as a matter of investment strategy while hedge funds are becoming more like mutual funds as a matter of the regulatory framework. This article identifies a trend of alternative mutual funds becoming more like hedge funds. It also shows that changes in the regulatory framework post Dodd-Frank Act pertaining to hedge funds tend to render hedge funds and hedge-fund-like-vehicles more mutual fund like. This is not just a result of more stringent regulations enacted via the Dodd-Frank Act in the aftermath of the financial crisis; the liberalization of the advertising restrictions post Dodd-Frank Act also makes hedge funds more like mutual funds.
Market forces are a significant factor in the emerging confluence of mutual and private funds. Changes to the capital markets precipitated by the financial crisis of 2007-08 and a very low interest-rate environment, in combination with the enormous growth of private funds, created, and over time increased, the demand for retail alternatives. The net assets of mutual funds employing alternative strategies have increased almost 200% from 2009 to 2014. Evidence of a growing number of side-by-side management structures, in which an investment advisor both manages mutual funds and hedge funds further suggests that investment advisers are adjusting their operations to satisfy retail investor demand for alternative investments.
The fundamental reshaping of the regulatory landscape for the private fund industry removed many of the legal differences separating the two industries. The Dodd-Frank Act and JOBS Act streamlined core legal requirements for the private fund industry, aligning them more closely with those applicable to the mutual fund industry and helping the private fund industry transition from a secretive industry to a less secretive industry supported by a more widely-recognized and influential group of investment managers. The registration and increased disclosure requirements for certain private fund advisers under the Dodd-Frank Act subjects private fund investment advisers to similar registration and reporting obligations as mutual fund advisers. The registration requirement under the Dodd-Frank Act in combination with the removal of advertising restrictions for private fund advisers under the JOBS Act and the equal treatment of mutual and private funds for FSOC’s SIFI designation in effect assimilated legal requirements applicable to mutual and private funds.
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